Back to basics: How does a credit card work and do you REALLY need one?

Credit cards can be a useful tool if you follow the rules. They can help you to budget, improve your credit rating and spread the cost of borrowing over time.

But there are hundreds of cards out there to choose from and getting the wrong one could mean you get a raw deal.

Read this guide to help you decide whether you really need a credit card, how they work and what it could cost you to avoid any credit card nightmares.

Do you use your credit card a lot? Make sure you have chose one which suits your needs

How they work

Credit card will allow you to borrow
and spend up to an agreed limit. You are then charged interest until the
balance is cleared.

Your
spending limit - or credit limit - will be decided by the provider and
depend on your individual circumstances, taking into account factors
such as income and credit history.

The
interest you pay will be agreed before you sign for your credit card. Remember - it may not be the rate you see advertised as providers only have to
offer this to 51 per cent of successful applicants.

Each month you will be sent an itemised bill of everything you have spent on the card. Most cards will come with period of a
month or so after the bill being issued before any interest is charged. If you always clear your whole balance within this time, you won't
pay any interest.

This interest-free grace period differs for each provider so check the terms and conditions. It could range
from anywhere between 20 and 55 days.

Repayments will not go through instantly so make sure you leave enough time to avoid any interest.

Card providers will have a minimum repayment that they require each month - this is usually either a flat cash amount, or a percentage of the amount you owe, whichever is highest.

It is important to make sure you keep on top of this minimum repayment as failure to pay could trigger late payment or default notes on your credit file which can affect your ability to take out loans, mortgages and other products in the future.

Paying the minimum repayment requested by your card company won't actually contribute much to paying off your balance. It will clear any interest that has built but only reduce the overall debt by a tiny amount.

Clearing even a small debt would take years if you only paid the minimum amount so always try to clear as much as you can afford. You can see how this works with our Credit card reality check calculator, which can also be found at the bottom of the page.

Watch out: Credit cards can be a great tool but only if you follow the rules

Protection

One of the biggest benefits of a credit card is the consumer protection it provides you in case your purchase goes wrong.

If you have paid using your credit card the lender takes on the same liability as the retailer if you don't get what you've paid for, for whatever reason. Under the 1974 Consumer Credit Act, Section 75 any purchases you make worth between £100 and £30,000 are protected by your credit card provider.

So if you don't receive the goods, or they are faulty and need fixing, you will be able to claim the cost of repair or replacement from the company you bought it from and the card you bought it on.

Improve your credit rating

Many people complain they have never applied for any credit - and therefore had no credit problems - yet have still been rejected.

Bizarrely, the credit industry feels more comfortable dealing with people who have a track record of paying off credit so you do actually have more chance of making a successful application if, for example, you have taken out a mortgage or loan previously.

This problem is easily solved. Take out a credit card, spend some money on it and pay it off each month. Lenders will now see that you can do this sensibly and will be more likely to lend you money.

The next step

Once you have decided whether you
need a credit card or not, the next step is finding the right credit
card suited to your needs.

There is a wide range to chose from
that have attractive offers on cashback, transferring debt, spending,
rewards and for helping you to build your credit rating.

READ THE NEXT CREDIT CARD GUIDE

With any card, it is important to discuss a
realistic credit limit with your provider.

It might seem like free money but you will have to pay the balance off
at some point, and your credit rating is at risk if you cannot pay off
your bills on time.

Sarah Robb, credit cards expert at uSwitch says: 'As a golden rule, whatever card you
have, set up a direct debit to make at least the minimum repayment every
month.

Make sure you register to the right
address - your credit history may be affected if you do not use the same
billing address as the one where you are currently registered on the
electoral roll.

THE WHOLE TRUTH - WHAT COULD IT COST YOU

Although some of the charges might not end up being relevant to you, you should
always check out the full terms and conditions for any card you are considering.

Avoid cash withdrawals

Probably the biggest hidden cost is the charge for cash advances. Most often these refer to ATM withdrawals, but can also include paying money into other accounts, buying travellers cheques and even gambling and betting transactions.

In these cases you will have to stump up a handling fee averaging more than three per cent.

There will also be an individual interest rate charged on the amount of your cash advance, usually considerably more than the standard interest rate - around 25 per cent.

Remember, cash advance amounts usually have no zero-interest grace period, so to avoid hefty charges it's best to check what falls into that category and avoid them at all cost.

Withdrawing money abroad usually comes under a
provider's cash advance rules, so with a standard card you can expect to fork out both the cash
advance handling fee and the interest on top if you use an ATM.

Plus, standard cards will also charge you between two or three per cent
charge for foreign currency exchange.

Stay within you limits

Most also carry a fee for spending beyond your credit limit, much like an unauthorised overdraft fee on a current account. There will also be late fees when you don't pay your bill on time. Providers usually charge a flat-rate £12 for each of these transgressions.

There also tends to be a fee for returned payments, if you try to make a payment when you are beyond your credit limit. This averages at around £11.

On top of all of these, there are flat-rate
charges for requesting a one-off paper statement, which could cost up to £6.

Credit Card Reality Check Calculator

Warning: This calculator does not factor in the time it would take to repay a credit card debt where the minimum payment is calculated as a percentage.

Your plastic debt

This calculator will show you just how long it's going to take you to clear your credit card balance if you don't wake up, face reality, stop paying the bare minimum and start clearing this punitive form of debt.

Your credit card balance:£

Interest rate:%

Monthly payment:£

Result

Number of monthly payments:

Clear your debt quickly

Now see how much you need to pay a month to clear your balance in the shortest possible time.

Loan Repayment Calculator

Credit Card Reality Check Calculator

Your plastic debt

This calculator will show you just how long it's going to take you to clear your credit card balance if you don't wake up, face reality, stop paying the bare minimum and start clearing this punitive form of debt.

Your credit card balance:£

Interest rate:%

Monthly payment:£

Result

Number of monthly payments:

Clear your debt quickly

Now see how much you need to pay a month to clear your balance in the shortest possible time.